Early Retirement is something on most of our minds but often seems like just a dream too far to reach. That is what I though before I came across the FIRE movement and learned how to plan for retirement.
The essentials of how one can get to Financial Independence and Retire Early (FIRE) are fundamentally the same and have been since the FIRE community started growing in the late 1990’s. We discussed the key FIRE concepts in the blog post Achieving Financial Independence: 3 Actionable Steps to FIRE and those are still very laid.
However, what has changed is the landscape around us since COVID and therefore its possibly prudent to think of how we pivot or tweak our strategy to get to financial freedom.
Saving Money: The Holy Grail Of Early Retirement
Saving money and investing the savings is the main vehicle to Early Retirement for most of us who are on the FIRE journey. The aim is to have enough savings that are well invested to be able to live off the investments.
The question then is, how much of our income should we save to make it viable. Traditionally, financial advisors have always said that you need to save 10% of your income towards your retirement. On the face of it that seems like a reasonable request and quite achievable. However, 10% actually not really sufficient if you want to get to Early Retirement. The example below should hopefully illustrate why 10% is just not good enough.
To work out what you would need to retire on, we in the FIRE community usually tell people to first understand their current expenses and then take a multiple (say 20 or 25) of the annual expenses to work out your savings target. This figure would then be the amount that you could live off, if invested well.
Why The Maths Of 10% Savings Is Not Feasible To Retire Early
Lets look at a simple example. Say you earned $60,000 a year and paid a flat 20% tax on it, leaving $48,000 in after tax income. Of the $48,000, you spent 90% on living expenses (so $43,200) and saved the 10% ($4,800). Now in the FIRE movement, we generally say that you need to take you annual expenses and times it 25 to get to the nest egg figure that you will need to be able to retire on.
So in the above example, if you spent $43,200 per year, you would need $1,080,000 saved up and invested to retire. Now if you saved 10% which is $4,800 per year in the above example, with very simple maths that would take you 225 years to save that amount!! Of course you need to invest and grow that amount as you save it, so a return rate needs to be included in this calculation to make it sensible.
If we use a healthy 7% return annually and use a compound interest calculator, it would take just over 40 years of saving and investing the $4,800 annually to get to the $1,080,000 target amount. Although that is good as a baseline, there are many factors that need to be considered here as well.
For one, you may not get 7% return every year, in fact you most likely wont. Markets go up and down and so do companies. The other thing to factor in is you may have some life events that prevent you from saving in some years. So just with these two factors, in reality it will take you more than 40 years to save that amount.
The other key factor to consider is inflation and the value of money. After 40 years, $1,080,000 will not be as large an amount as it is today. Also over time, your expenses will go up as well.
So What Should I Ideally Save?
As you see from the example above, saving 10% is good but definitely not good enough for Early Retirement. It could take a long time to save enough to be able to cover your expenses. In the above example, expenses of $43,200 per year took just over 40 years to save for at 10% based on the income. 40 years of saving is not exactly going to allow you to retire at a younger age. It will of course help if you plan to retire around 65 or later, so don’t discount any saving rate as such!
So what is the ideal saving rate for FIRE? Some say, you should save at least 30% and some say you ideally want to save %70 to retire within 10 years. The reality is the truth sits somewhere in-between and is completely based on your situation. Obviously the move you save, the faster you will get to retirement, you don’t have to be a math genius to figure that out.
It’s about what is more realistic. To save 70% of you income, you would have to live quite a lean life. It can definitely be done and there are lots of example of it but you have to be very flexible and creative. A good example of how some save 70% is with a form of house hacking.
Increasing Saving By House Hacking
House hacking is a term used to generate income from the place that you live in. You may be a renter or you may own the house, that does not matter. It’s finding a way to earn income out of the house to cover your expenses. Say you were single and renting. You could either live with flatmates or rent a full house or apartment yourself.
If you rented the full house or apartment, you would most likely be paying a decent amount of rent, along with all the associated expenses. That would not really help with your savings rate for Early Retirement, as a lot of your income would be consumed in these living costs. But what if you sub- rented out room or two in the house or apartment you live in? Sure your rent would not change and you would have to get the permission of the house owner to do so. But you would substantially reduce your own costs by the additional income.
Say you were paying $400 a week in rent for a 3 bedroom apartment. If you rented the other 2 bedrooms for say $150 each per week, you would get $300 per week in income. That would mean you would only have to pay the additional $100 per week to make the total of $400 per week in rent for the apartment. So you effectively went from paying about $20,000 in rent a year to about $5000 a year, saving yourself $15,000 in the process. That my friends is a great example of being about to live on a lot less than you needed to and saving more.
Of course these are a lot of ‘life’ factors that come into the mix here, its never that simple. You may not have a 3 bedroom apartment, you may just have 2 bedrooms and you need the second bedroom for all your stuff and for guests when needed. You may also not really want flatmates and prefer to have your own space. But there are ways around all of these obstacles as well.
As the old saying goes, where there is a will, there is a way. You could get a 3 bedroom house or apartment that has its own self contained area, which you can use and rent the rest. For guests, you can always hire an Airbnb close by for the time they come.
Increasing Income To Increase Savings
Sometimes, increasing savings rates is just too challenging due to fixed commitments and responsibilities. Also, you can only save that much sometimes, as much as you live a frugal life. So perhaps we flip this conundrum on its head and look at ways of increasing the savings, by increasing income.
The house hacking example above is really an example of both increasing income and savings. By getting more income (rent from flatmates) you are able to increase your savings (saving $15,000 a year in the example). So its all about perspective and mindset to overcome challenges.
Let’s take an example of a couple with 2 kids, which is quite different to the single person with flatmates. The couple would definitely have a higher level of expenses and responsibilities, making savings a lot harder. But if you changed perspective, it also means that there are two people who can earn. So the potential of increasing income is higher than the single person. Of course you have to consider the additional responsibilities with the two kids.
The couple could also use a form of house hacking to increase income. It may look quite different to the single person with flatmates of course. Perhaps they could still use part of their house to rent to someone to get more income. They could also help look after other parents kids for short periods after school to make more money.
Sacrifice and Hard Work To Achieve The Early Retirement Dream
Some of the ideas above may sound like a lot of inconvenience and hard work. Particularly, the examples of how a couple with two kids making more income could be controversial. However, its all about perspective as I always say. When you look at the big picture, it may not be that bad.
So the couple with two kids have to work harder in the example and that is tough for parents. Its exhausting having to look after two young kids just in themselves. Do you really want the hassle of having more kids to look after to make a bit extra? Does not really sound appealing, does it?
But what if you looked at it this way. The couple does not want the hassle now as they are busy. But what about in 10 years when they will possible have less money or saving than they could have had? Say the couple was in their mid 20’s at the time. So when they are in their mid 30’s they would need to perhaps work hard in some other way. If the goal was to retire in their mid 40s, they would have lost 10 years of savings and compound interest along the way. This in turn would mean they would possible have had to work longer before retiring.
So when you put the lens of perspective, perhaps some extra hard work in the beginning is not that bad. Compare it to having to work an extra 5 or 10 years. What’s better?
